Yves here. We’ve written approvingly of Claudio Borio’s work, since he (along with the BIS’ William White) warned central bankers of the dangers of synchronized housing bubble well before the crisis. The then-celebrated Alan Greenspan airily dismissed those concerns.

Another important paper by Borio, Global imbalances and the financial crisis: Link or no link? hasn’t had the impact it should have. Borio and co-author Piti Disyatat decisively debunked the saving glut theory, which former Fed chair Ben Bernanke has pushed (and sadly probably even believes) as the explanation for the crisis. That theory, conveniently enough, exculpates central bankers of blame for the financial meltdown.

When Claudio Borio speaks, the big bankers and investors, the economics profession, and senior policymakers listen quite carefully—even if his sentiments don’t reach the shores of the popular media. Borio, the chief economist for the Bank for International Settlements (BIS), the central bankers’ central bank, recently remarked on the fragility of the global economy, and suggested that we were on the verge of a significant relapsesimilar to the global crash experienced 10 years ago. Among the parallels he perceives: the proliferation of “collateralized loan obligations (CLOs), which are ‘close cousins’ of the infamous instruments known as collateralized debt obligations, or CDOs, and securities backed by residential mortgages,” the prevalence of which helped to crater the credit system in 2008.

Mindful as central bankers have been about the ready availability of liquidity, they have (as I have written before) omitted to “proactively… [charging] private market participants variable risk premiums commensurate with the risk of the underlying activity they are undertaking when providing credit.” Furthermore, Borio implies that the monetary and fiscal authorities expended excessive efforts toward restoring the status quo ante, instead of directing policy toward broader job creation and income generation, which would place the economy on sounder footing when the next downturn inevitably comes. Finally, the BIS’s chief economist also publicly mooted whether additional “medicine” of the kind that we used last time will be in sufficient supply to respond adequately when the next crisis emerges.

So is Dr. Borio correct in both his diagnosis and concomitant concern about the lack of readily available cures for the prevailing illness? And are there any key omissions in his analysis that could help to mitigate the inevitable relapse that he forecasts?

Borio has a good track record in terms of forecasting economic crises. As early as 2006, he was presciently warning about the risks to the economic upturn posed “by the unwinding of financial imbalances that occasionally build up over the longer expansion phases of the economy,” in marked contrast to most experts at that time, who often sounded Pollyannaish in comparison.

To be sure, there are ample grounds for Borio’s caution. He correctly observes the revival of many of the speculative instruments that created so many problems back in 2008, even as policy officials continuedto “administer… ‘powerful medicine’ to counter the effects of the crisis, with ‘unusually and persistently low interest rates.’” Paradoxically, the cure was almost as bad as the disease, given how aggressive monetary ease helped bring these instruments back from near death.

There is no question that in a world dominated by high and persistent levels of debt (particularly private debt), low interest rates helped to reduce the crushing burden for borrowers. But to extend the medical analogy, using interest rates to cure a global debt deflation is akin to using a sledgehammer during surgery, rather than a scalpel. There are diffuse outcomes for the cure. For every borrower aided by lower rates, there are savers (pensioners, et al) who have been adversely impacted by the prevailing low interest rate structure. Savers secure less income from minimal interest rates on their assets. Recall that when the government runs deficits, it is a large net payer of interest on its outstanding debt.

There are also supply-side issues: Low interest rates actually exacerbate prevailing deflationary trends, because the corresponding reduction in the cost of capital reduces the threshold to turn a profit, which in turn can induce greater supply and production. In addition, under a low interest rate environment, the cost of holding inventory is very low, which may mitigate the possibility of supply bottlenecks, but also potentially creates oversupply.

Raising or lowering interest rates to affect demand is therefore less effective than fiscal spending. Government spending directly targets demand deficiencies, and net injections of government stimulus into an economy can override the impact of interest rate manipulation.

No less an authority than former Federal Reserve Chairman Ben Bernanke has indirectly confirmed this claim. In a paper dated from 2000, then-Professor Bernanke made the claim that, in a deflationary environment (which he was discussing at that time in the context of Japan), monetary policy could be effective to the degree that it retained “fiscal components.” He fretted that as interest rates plunged close to zero in the face of rising deflationary pressures, any income derived via the interest rate channel would be dissipated. That is why he advocated having the monetary and fiscal authorities working closely in harness to ensure that deflation was beaten.

Which raises the question that Borio doesn’t really answer directly: If central banks continue to wean their respective economies off low interest rates, is it inevitable that the economy will suffer a relapse? Surely, government spending and taxation decisions (which are among the first policy levers used to deal with recessions) could offset this impact, because they more directly affect demand and, if deployed aggressively enough, can offset any negative impact derived as central banks raise rates. This would imply that Claudio Borio’s implicit concerns about the withdrawal of the “low interest rate medicine” would in and of themselves overstate the problem with said interest rates rise (as they are today).

The more germane consideration that goes to the heart of Borio’s concerns (i.e., that we have run out of policy space) is how best to address a future economic relapse. Being a central banker, it is understandable that Borio places emphasis on monetary policy. But is fiscal policy subject to the same kinds of limits? Have governments have run out of fiscal policy options as a result of the measures undertaken in 2008 and the corresponding rise in public debt levels (as much private debt was “socialized”—i.e., taken on the balance sheets of governments to pay for bailouts and the like)?

Under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. … The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.

This statement has often been misinterpreted as implying that deficits don’t matter, and Bernanke himself was often savaged for his advocacy of “helicopter money.” But his NEC speech simply states the obvious: namely that in the absence of some sort of external constraint (whether a gold standard, or borrowing in a foreign currency), a government with a free-floating fiat currency always has the financialcapacity to spend. However, it does face real resourceconstraints, which can render its activities inflationary—for example, if, as Professor Randy Wray has argued, “the economy runs up against a full employment constraint, but government stubbornly keeps spending more.” Although, as Wray notes, “The last time the US approached such a situation was in the over-full employment economy of WWII. Rather than bidding for resources against the private sector, the government adopted price controls, rationing, and patriotic savings. In that way, it kept inflation low, ran the budget deficit up to 25% of GDP, and stuffed banks and households full of safe sovereign debt.”

The point is that any policy limits that would impede our ability to respond to Borio’s feared economic relapse are largely political in nature. A necessary foundation of economic stabilization policy means that policymakers must be ready, willing and able to employ policy buffers that are large enough to do the job, and not simply operate with some preconceived notion of “financial sustainability.” At the same time, can policymakers undertake aggressive fiscal measures without re-igniting yet another bubble in the most puffed-up dimension of the economy— the figure-eight of CLOs/CDOs issued, sold and traded and the corresponding insurance products sold against them? And can they find a way to slowly let that air out of the bag without creating a full-blown discontinuity?

Beyond that, a genuinely effective policy is one that not only boosts spending if and when the economy collapses, but also expediently improves the income and employment condition of those at the very bottom of the income distribution. Historically, this hasn’t been done well. As Professor Pavlina Tcherneva has illustrated, “Only during the 1950-53 expansion did the bottom 90% capture all of the average income growth in the economy. Since then, the top 10% of households have been capturing greater and greater share of the income growth and, in the first two expansions of the 21st century, they have captured all of the income growth.”

Tcherneva’s analysis explains why the fiscal initiatives undertaken by Bush, Obama and Trump administrations, respectively, have been comparatively muted in terms of impacting the broadest swaths of the U.S. economy. Aside from the obvious morality question, growing inequality generally causes an economy to work at less than optimal efficiency, which makes sense intuitively in that it becomes increasingly difficult to grow an economy rapidly if the bulk of the gains are increasingly funneled to a smaller and smaller number of people (especially if they have the highest savings propensities).

In addition to the inefficiencies brought about by growing inequality, fiscal policy has tended to be biased toward “trickle-down economics” in which the benefits of government spending/taxation decisions “trickle down” to the population as a means of stimulating employment and income gains, as opposed to focusing directly on programs that cover “labor gaps” through direct employment programs such as the Job Guarantee(JG). The virtue of the JG, as the economist Hyman Minsky argued, is that “instead of the demand for low wage workers trickling down from the demand for the high wage workers, [policy orientation] should result in increments of demand for present high wage workers ‘bubbling up’ from the demand for low wage workers.” This can be better achieved via the JG, than, say, tax cuts.

Above all else, we need to avoid monetary machinations and central bank overreach, which simply move to restore the economy to an unsustainable status quo ante. Policymakers must also embrace fiscal initiatives that reorient policy away from demand-side trickle-down measures and toward a bottom-up approach that is based on employment and reducing inequality. Absent these considerations, Claudio Borio’s concerns will be validated: The economy’s recovery will be uneven, and the convalescence, such that it is, will be lengthy, intermittent, and maintaining many of the same pathologies that our economy displays today.

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49 comments

Is there some unspoken rule that negative interest rates are off the table? While I agree with most of this analysis that suggests that fiscal policy is more effective and targetable than monetary policy, it seems most of these discussions of “policy space” ignore the possibility of negative rates. I wonder why.

Amen Carla. Fine, make it negative 10%–what the hell. As long as we can take the same negative ‘cut’ from every economist’s salary. Of course providing we find out who is actually paying them to come up with this sh..t.

You have to cut the economists a little slack, as the rules they thought were sacrosanct, weren’t so much anymore when we decided to bail ourselves out with nill-gotten gains.

Call them ‘Dismal Scientologists’ as they have no reason to exist anymore…

It’d be akin to an expert on chess, being told that some pawns were now worth as much as a queen and capable of the same moves, but only on alternating Tuesdays in non leap years, and as an added bonus, nobody was really sure which pawns held the power, as they all looked the same.

Paul O, that is a perfectly valid political explanation (if you can show the political mechanism or channel by which the “apolitical” Fed takes this into account), but I am looking for a technical/policy explanation.

The effective zero lower bound. The paper dollar under a monetary rate that leads to banks offering negative rates, will lead to people withdrawing their money and stashing it in a mattress or in Japan’s case a safe (increased sales as they approached the EZLB).

People react differently to seeing the amount in their account decrease, while do not react the same to a loss in purchasing power due to the rate on their accounts being lower than inflationary rate.

One solution was to have a conversion rate policy equal to the monetary rate between the paper dollar and credit-dollar, necessitating dual pricing schemes by merchants (unless they are fine with losing a few percentage points).

The other was going cashless, but thats unlikely given the failure in India in demonetization.

Obvious problem: Savers cash out their savings en masse, giving rise to bank runs. Cash under the mattress does not attract interest, negative or otherwise.

When interest rates are at their lower bound, the onus is on the government to create and spend money in the real economy- – through public works programs and the like – until we get close to capacity constraints and can increase interest rates.

Depends where you live. In countries like France and Denmark, public spending around 57% of GDP, it is arguably the government and not management that exploits the people who get dirt on their hands. There may have been a decline in the labor share of GDP in recent decades, but it is the government share that has increased. There’s no more powerful lobby for keeping this tendency going than the public education, health and social welfare sectors, whose staff, when you get chatting to them, seem to think that they alone are the ones that create the national wealth.

Because negative interest rates encourage people to hold physical cash, draining the banking system of deposits. In order to avoid that, governments have to ban physical cash. In response, people will start stockpiling shelf stable, high value items like gold, jewelry, etc.

The only thing it seems to be effective at achieving is a devaluation against other currencies. ECB and C Bank of Japan have used neg interest rates in such a manner, and effectively so. Of course, it’s a zero-sum game, encouraging others to go negative to compete.

In short, it’s a policy only a neoliberal could love. It avoids directly addressing a problem, choosing to waterboard the private sector into doing its bidding. It also has lots of pernicious side effects that are easily forseeable by anyone thinking about it for five minutes. Plus its oppressive while giving a kind of ridiculous plausible deniability that it such. It’s really the most idiotically neoliberal policy I can think of.

Did i mention that it doesn’t solve the problem of putting money in people’s pockets? After it’s been in place, private sector balance sheets are still in need of repair. I’d put it right up there with auserity policy.

We run a $600,000,000,000+ annual trade deficit with the rest of the world.
In exchange for their “stuff”, the rest of the world gets $USD’s.
Paying them negative interest rates on those USD’s would be an all too obvious form of PLUNDER (as opposed to the less obvious form practiced now).

Monetary policy is the wrong tool to use when consumer demand is insufficient. John Maynard Keynes explained that all to the world in the 1930s. It is still true, no matter what monetarists try to fool you with. Tax-cuts and zero (or negative) interest rates are all tools from the monetary toolbox. Fiscal stimulus by government requires spending by government. Collecting less taxes is not the same as fiscal stimulus just as pushing on a string is not the opposite of pulling on a string.

Because they are a terrible idea. They are strongly deflationary, which is the opposite of what they are supposed to achieve.

First, they explicitly signal deflation expectations.

Second, they deprive savers of income, so they hunker down and try to save even harder, as opposed to do what economists fantasize they ought to do, which is spend more principal. People who are living off savings are terrified of running out of money unless they have quite a lot of it.

Third, they encourage people to hoard by holding cash or buying real assets, which is again rational behavior in deflation.

While I agree that targeted fiscal policy can cure economic malaise to a large degree, the caveat i’ll insert is that its effectiveness is often compromised by the “targets” for such fiscal spending being the top-of-the-food chain constituencies (I.e. the donor class) of the incumbent ruling parties, with the result that the gains derived from such fiscal interventions flow (read “are channelled”) towards said donor class constituencies, exacerbating income inequality and stalling economic recovery because of the upper 10% propensity to save instead of spending into the economy. Interventions that target employment creation for the bottom 90% are therefore, to my mind, the only sustainable remedial measures that can solve this conundrum.

Why do we mopes persist in calling them the “donor class?” How about the “looter class?” Maybe the “briber class?” Or most telling, the “Ownersofalmosteverything (OOAE) class?”

“Donor” implies come kind of beneficent intent and behavior. Nothing of the sort,of course — it’s all about inward and upward concentration of wealth. The only constraints being exhaustion of the planet and its formerly (we mopes thought, in our bland way) Great Commons.

“I can pay half the working class to kill the other half,” said Gilded Ager Jay Gould. And of course from the currently number 3 “richest men in the world,” Warren “Who’s your friendly rich uncle” Buffett, there’s this: “There’s class warfare, all right,” Mr. Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.” More on that from the conservative “deficit hawk” NYT article by Ben Stein, who ends it up with this ultimate laffer :

THIS brings me back to Mr. Buffett. If, in fact, it’s all just a giveaway to the rich masquerading as a new way of stimulating the economy and balancing the budget, please, Mr. Bush, let’s rethink it. I don’t like paying $7 billion a week in interest on the debt. I don’t like the idea that Mr. Buffett pays a lot less in tax as a percentage of his income than my housekeeper does or than I do.

Can we really say that we’re showing fiscal prudence? Are we doing our best? If not, why not? I don’t want class warfare from any direction, through the tax system or any other way.

There is a special place in Dante’s Inferno for Joe Biden. In addition to that, he’s responsible for the sham Anita Hill hearings as well as the Biden rule, turned into the Merrick Garland rule, and lest he be forgotten for his “handsy” way with females at public events.

Republican Ike got elected, the MICC assumed “full spectrum dominance” in the warm afterglow of WWII, and Wall St got the message that from here on out it was to be all financial parasitism all of the time, with only brief interludes of false contrition occasionally thrown in as PR stunts.

In the context of the politically mad governance of the US, UK and EU, there was no need to consider the possibility of sane fiscal policies. Neoliberal orthodoxy has pushed them off the table. The only fiscal stimulus the US allows is deficit- financed weapons purchases and black ops.

I actually have never tried to put lipstick on a pig, but this article is inspiring. I especially liked the part about how “we need to avoid monetary machinations and central bank overreach . . .” After the QE horses are out of the barn and the financial aristocrats have received their stipend guarantee, we should turn to helping them provide for workers with a “jobs guarantee.” We need the income growth to be for the bottom 90%, so we will provide for the oligarchs to dream up worker activities which the taxpayers fund through deficit spending. We will not mention the idea that taxes are unnecessary while we discuss the jobs guarantee. The balance we seek is within the flows of the financial system and not in government accounts. We will carefully strengthen the ruling class grip on money creation and distribution while we piously discuss our genuine concern for the precariat. If the financial system should again become unstable, we can briefly regress to restoring the oligarch accounts as required to stabilize the jobs guarantee, with “policy buffers that are large enough to do the job.” When demand for high paid workers bubbles up from the precariat, it will be worker wealth creation, not price inflation. This balances nicely with having financial wealth creation instead of financial asset inflation.

Claudio Borio feels the world economy is fragile. He cites crises in Argentina and Turkey, the Fed and European Central Bank are raising interest rates, asset prices in emerging economies are suffering from a stronger dollar, the Chinese economy appears to be slowing. And “US-dollar-lending to non-banks in emerging economies ‘has actually more than doubled since the Great Financial Crisis to some $3.7 trillion'”, and this does not “include borrowing through so-called foreign exchange swaps”. To this add that the US has a “red-hot” leveraged loans market fat with collateralised loan obligations (CLOs) palmed off to eager investors. [ref the “on the verge of a significant relapse” in the first paragraph]

Our current financial markets were carefully rebuilt in the image of the failed financial markets of the Great Recession right down to retaining and rewarding the architects of that failure. Since the Great Recession governments have continued their screwy monetary policies while avoiding any fiscal policy that might help the growing hordes of skinny borrowers.

Why is Claudio Borio worried now? We have the same broken economy that brought us the Great Recession. I guess pressures are building as before … but what makes Claudio Borio so worried now? What tipping point looms or tripwire appears to catch?

The Fed sets the rate for the dollar where it chooses. Higher rates can be avoided if the Fed chooses to avoid them. Monetarist ideology is what prevents the Fed from avoiding this particular mistake which Borio is trying to state to them in terms they can understand through the fog of their Freidmanite ideology.

In the 1930s, they pondered over where all that wealth had gone to in 1929 and realised inflating asset prices doesn’t create real wealth, they came up with the GDP measure to track real wealth creation in the economy.

The transfer of existing assets, like stocks and real estate, doesn’t create real wealth and therefore does not add to GDP.

Banks can create real wealth indirectly by lending money into business and industry.

2008 – “How did that happen?”

The financial wealth creators weren’t creating real wealth. They were just inflating asset prices and that sort of wealth can just disappear almost over-night, as it did.

Real wealth doesn’t disappear over night

The real wealth in the economy is measured by GDP.

The financial stability of the Keynesian era came from knowing how to create real wealth.

In an ‘age of fraud’ powered by a neoliberalism’s ‘shadow elite’ who promulgate and prosper from it, whatever ‘trickle-down’ measures (if any) are sure to be subverted and co-opted, if not outright looted. This is the reality we are in.

Return with us now to those thrilling days of yesteryear…
~~~~~~~~~~~~~~~~~~~~~~~~~~

His pride does drive him to the point
That he gets notions in his mind
To do whatever he may please.
Profiteering heats his very breast
And since his mind floats in the air
Without a conscience he exists
In greed and trickery, pride besides
But it will seldom last long or well.

Kipper und Wipper (German: Kipper- und Wipperzeit, literally “Tipper and See-saw time”) is the name given to a financial crisis during the start of the Thirty Years’ War (1618–48). Starting around 1621, city-states in the Holy Roman Empire began to heavily debase currency in order to raise revenue for the Thirty Years’ War, as effective taxation did not exist.

The name refers to the use of tipping scales to identify not-yet-debased coins, which were then taken out of circulation, melted, mixed with baser metals such as lead, copper or tin, and re-issued. Often the states did not debase their own currency, but instead manufactured low-value imitations of coins from other territories and then spent them in yet other territories as far as possible from their own lands, hoping that the resulting damage would then occur to the economy of those other regions rather than their own. This worked for a while; but after a time, the general public caught on to the manipulation, resulting in pamphlets denouncing the practice, local riots and the refusal of soldiers and mercenaries to fight unless paid in real, non-debased money. Also the states began to get back their own debased coins in taxes and customs fees. Due to these problems the practice largely stopped around 1623; however, the damage done was so large that it created financial disarray in almost all the city-states in the area. The same thing re-occurred on a smaller scale near the end of the century and again during the middle of the 18th century; however, the debasement spread from Germany to Austria, Hungary, Bohemia, and Poland.

I guess you don’t think much of the dollar coins like the Susan B, the unknown Presidents, or the Sacajawea dollars. I affectionately call them Chuckie-Cheese money, handy for paying the road tolls or meaningfully contributing to spare-changers without pulling out a wallet.

There is so much wrong with the BELIEFS and “logic” of this piece of propaganda, that a child, who has not been subjected to decades of disinformation and idiological subversion, could destroy it in seconds. It is NOT “policy makers” (who have been consistantly wrong and created the problems) who provides “financial sustainability”. It is the productive capacity of the people that make all things possible.

It has been policy makers, which includes career politicians, that not only blow the bubbles and off-shored the higher paying jobs, but their self-interested actions have been eroding the pillars of free-market capitalism for decades – trust, confidence, and the rule of law.

It has also been policy makers that created the “wealth gap”, which has been caused by the difference in ASSET APPRECIATION strategies, not incomes. If Social Security funds were invested the way the “wealthy” invest, we would not be talking about a SS crisis or a wealth gap.

It has been policy makers that malinvested hard-earned taxpayer money and misallocated stimulus funds. If the Fed was buying corporate bonds during recessionary periods, instead of treasuries, as was intended, more jobs would be preserved. As we have seen, you cannot force people to borrow or banks to lend if opportunity and confidence do not exist. Policy makers destroy both.

The following sentence is indicative of the Marxist idiology that plagues this article – “a genuinely effective policy is one that not only boosts spending if and when the economy collapses, but also expediently improves the income and employment condition of those at the very bottom of the income distribution.”

First of all, it is not “if or when” an economy contracts. Only the hubris of a policy maker allows one to believe that the business cycle can be manipulated or eliminated. Paul Volcker admitted as much decades ago. Secondly, while govt spending has the potential to stimulate, if done selectively and effectively, govt NEVER does anything effectively and govt programs NEVER get dialed back after creation. The “broken glass” theory of job creation was disproved long ago, as the money that is spent on things that are repeatedly destroyed is much better spent on improving prosperity, which is also why wars, that have been largely manufactured by policymakers, is the worst of all govt spending debacles. Thirdly, productive incomes are not meant to be distributed, but earned.

If policy makers did not sell off high-paying jobs to foreigners, replacing them with jobs that require little or no knowledge or experience, then the low paying jobs would have remained starter jobs instead of one’s required to sustain a family. It is once again, policy makers, that are now replacing the low-paying jobs with robots. It is high medical costs (primarily caused by govt not enforcing EXISTING anti-trust laws and mandating transparency) that has forced the consideration of robots; and it has been artifically low interest rates, imposed by policy makers, that have made the financing of robots practical.

Standards of living are increased by adding value, and value is maximized by rewarding the people that produce it, not simply paying people to do low-value added jobs. Living standards are also increased by reducing polution, which is why the poorest countries are the most polluted. Prosperity permits profits to be used to increase living standards in the cleanest way possible. Instead, policy makers waste time and money selling the falsehood that historically changing climate cycles are responsible for pollution. We should be preparing for the coming mini iceage, which are much more harmful than periods of warming, when societal expansion occurs. Cooling cycles have historically been associated with crop failures, famines, and plagues, as immune levels are weakened. This will be especially pertinent over the coming decades, as we are also entering the peak of the earthquake and volcanic cycle, when ash can block the sun for extended periods, especially when the big one blows.

It should be obvious to those that don’t let their beliefs and biases impede their thinking that artifically increasing low value-added jobs DO NOT cause high-wage jobs to “bubble up”. It’s the same reason policy makers cannot force people and business to borrow, and they should not force banks to make subprime/risky loans, no matter how much QE is done. It is only trust, confidence, and an equally enforced rule of law that will attract capital and incentivize people to take the risk to improve their lives and society in general. Job Guarantee (JG) programs are the thing of big govt, command and control economies, that not coincidentally, have the lowest standards of living.

Fortunately, although it is not the preferred path, the funding of govt largess (Socialism) is coming to an end with the popping of the govt debt bubble. Yes, after over 35 years of declining rates, that permitted policy makers to sell their promises (lies) with increasing amounts of debt without increasing interest expense, interest rates have started their multi-decade rise that will blow up budgets around the world. Of course, policy makers (establishment) will do ANYTHING to maintain their perks and power, as we have been witnessing. Instead of looking in the mirror and admitting their mistakes and reforming, policy makers will try to squeeze blood from a stone (tax without representation), and history is very clear where this policy leads.